What Makes a Home Office Work?

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The right home office setup helps you operate efficiently and profitably—and offers a range of tax benefits

The Internal Revenue Service (IRS) reports that 23.1 million 2007 income tax returns reported nonfarm sole proprietorship income, a 4.7% increase from the previous year's filings. And those sole proprietors are generating serious money: their 2007 profits totaled $280.6 billion. Not bad for a work demographic that includes part-timers and those working from home.

If you own a small business, there are many advantages to working from a home office. For starters, you eliminate the overhead associated with office space rent, utilities and related expenses as well as commuting time and costs. But to conduct business effectively, productively and profitably from home, it's essential to have a well-defined and well-equipped office.

Make sure your computer is equipped to handle all your business requirements. Load it with the newest generations of all the software you'll need so you never have difficulty accessing client attachments. If space is limited, equip your office with an all-in-one printer, scanner, copier and fax machine. Trips to the copy shop can consume valuable income-producing hours and interfere with your ability to meet deadlines. And invest in a good data backup service so you never have to worry about losing mission-critical files.

First off, it makes sense to ensure that, for the best performance and efficiency, your Internet and phone lines are separate. A high-speed Internet upgrade will allow you to receive large files without disrupting your workflow. A good business phone is also indispensable. Look for one that has a speakerphone, hold and mute buttons, and then supplement those features with Caller ID, three-way calling and voicemail. Your phone service provider can offer additional advice about features that can support your company's success.

In terms of structure, Business.gov, a service of the US Small Business Administration, offers online advice about how to register your business name, obtain a tax identification number for your company, and complete business license and permit filings. You may also find it helpful to consult SCORE's how to set up a home-based business checklist.

On the tax benefits side, if your workspace is separate from your home and used exclusively for business on a regular basis, portions of your mortgage payment (or rent), real estate taxes and homeowner's (or renter's) insurance are all tax-deductible. However, the home-office deduction cannot exceed your income from the venture, so if you operate your business only part-time, and generate only a modest income from it, bear that in mind.

Kelly A. Chambers, CPA, the small business manager at CPA and business consulting firm Stambaugh Ness, PC, of York, Pennsylvania, says one simple litmus test can help assess the validity of any deduction you're considering taking. 'My rule of thumb is: If I didn't have this particular business venture, would I still have this expense? If the answer is yes, then it's not going to be a deduction.' She offers the following tips regarding deductions:

• Calculate the square footage of the home office against the square footage of the entire home. That will give you the percentage of utilities you can deduct as a business expense.
• If you maintain a separate business phone line, that's deductible. If not, only the cost of long-distance business calls qualifies as a business expense.
• Take a deduction for mileage or mass transit costs you incur when traveling to business meetings, even if they're local.
• If you combine a business trip with a family or personal vacation, you can deduct only those of your expenses directly related to your business activities on the trip.
• Account for barter deals on your Schedule C, even if no money changed hands or the value of the services zeroes out and you owe no tax on the exchange. Assign a value to services provided and received and include them on your return. 'That way, you are recording the transactions properly and you don't need to worry about any issues with the IRS,' Chambers says.

The IRS Virtual Small Business Tax Workshop guides home-office users and small business owners through tax procedures and requirements. The three-hour interactive workshop includes nine lessons and is subtitled in English, Spanish and Mandarin Chinese. You can also order up to five copies of the workshop on DVD at no cost by calling 800-829-3676 and requesting Publication 1066C.